Should Cyprus Leave the Eurozone?

     Yes, says Paul Krugman. He argues that to stay at this point will lead to an "incredibly long and severe depression."

      "The reason is straightforward: staying in the euro means an incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding."

       http://krugman.blogs.nytimes.com/2013/03/26/cyprus-seriously/

       An incredibly severe depression. As the country only has two industries-tourism and banking-and one of them is now gone it will face lots of pain no matter what. However, by leaving the Euro Cyprus can at least avoid austerity:

      "If you look at Cyprus’s trade profile, you see just how much damage the country is about to sustain. This is a highly open economy with just two major exports, banking services and tourism — and one of them just disappeared. This would lead to a severe slump on its own. On top of that, the troika is demanding major new austerity, even though the country supposedly has rough primary (non-interest) budget balance. I wouldn’t be surprised to see a 20 percent fall in real GDP."

      What about the worry of folks like Barry Eichengreen that leaving the Euro will lead to capital flight and bank runs? Krugman argues persuasively it's now moot:

      But is it even possible to leave the euro? The Eichengreen point — that even a hint of exit would cause panicked capital flight and bank runs — is now moot: the banks are closed, and capital is controlled. So if I were dictator, I’d just extend the bank holiday long enough to prepare for the new currency."

     However, Krugman acknowledges this is not likely to happen quickly it it does:

     "My guess is that none of this will happen, at least not right away, that the country’s leadership will fear the leap into the unknown that would come from euro exit despite the obvious horror of trying to stay in. But as I said, I think euro exit is now the right thing to do."

      So leaving the Euro will at least avoid more austerity while the reasons to stay in the Euro-avoiding bank runs and capital flight-are already gone. 

       Sumner on the other hand agrees with Ygesias. 

     "Matt Yglesias gets the entire Cyprus–Germany thing exactly right."

      Ok, if Ygelsias gets the whole thing right, let's hear from him. Before reading Ygelsias I guessed that whatever opinion he espoused it wouldn't show much concern for the terrible plight for Cyprus but argue they got what the deserved or in any case, the greater Macro good requires it: I say this not so much due to my character assessment of him but of Sumner. If Sumner likes it you can guess this is what he said. He indeed said just that:

       "John Cassidy says the David and Goliath story of Cyprus versus Germany has just one problem—the Germans are basically right."
  
      "I think that's true. The basic German view that the German taxpayer should bear less than 100% of the burden of rescuing the Cypriot banking system, and the creditors of the Cypriot banking system should bear more than 0% of the burden is very sensible. The decision of the Cyprus' president to organize a version of that principle that involved haircutting small depositors in order to protect the interests of Russian tax dodgers was perverse, but that's on him. If the Germans made a mistake here it was by being too deferential to President Anastasiades horribly flawed judgment. The Cypriots have been flailing around trying to find a solution that allows them to keep operating as an offshore banking sector, but the German government is correct to but zero (or even negative) weight on this as a policy priority."

     "The reason it's sometimes difficult to see that the Germans are right about Cyprus is that their political consensus is so wrong about Europe. Having the European Central Bank run an excessively German-focused monetary policy (indeed one that's arguably even too tight for Germany) is greatly exacerbating all these fiscal problems. Then Germany, as the party with the fiscal capacity, needs to pay some of the price at which point German voters lash out at peripheral citizens whose economies have been put in a situation where failure is inevitable. Indeed, contemplating the question of why Germany let a tiny offshore banking hub that had already lost de facto control over 40 percent of its small landmass into the eurozone in the first place underscores the generally low quality of thinking about how this whole operation is supposed to work."

     "But on Cyprus, they've got it right."

 http://www.slate.com/blogs/moneybox/2013/03/23/germany_s_right_about_cyprus_german_s_wrong_about_europe.html

     The title of Cassidy's piece: "The E.U. and Germany are Right to Bully Cyprus."

     Interesting title. He is suggesting that it can be right to bully in some instances. 

     "With the parliament in Nicosia about to vote on a revised bailout plan that could see one or two of Cyprus’s biggest banks broken up, the introduction of strict limits on cash withdrawals, and some depositors suffering losses of up to forty per cent, it’s easy to feel sympathy for the Cypriots. Ever since the European Central bank, at the behest of Germany and other big countries in the European Union, threatened to cut off emergency funding for the Cypriot financial system, the tiny island has been faced with Hobson’s choice: either it accepts the harsh measures imposed by the E.U., or it crashes out of the euro and watches its banking system collapse."

     "In this story of David and Goliath, though, there is a twist. To a large extent, Goliath is in the right. Now that it has dropped a proposal to impose losses on small depositors—an idea reportedly put forward by the Cypriot government because it didn’t want all of the burden to fall on the owners of large deposits (including many Russians)—the demands from the E.U. are tough but reasonable. Like Ireland and Greece before it, Cyprus is suffering from circumstances beyond its control—the economic problems of its neighbor Greece, and the wider European debt crisis—but it also played a significant role in its own downfall."

     Read more: http://www.newyorker.com/online/blogs/johncassidy/2013/03/why-germany-and-the-eu-are-right-to-bully-cyprus.html#ixzz2OkSH18mf

     Ok. So does Cassidy think the deal is right because he thinks Cyprus played a role in it's own downfall? So if they didn't would it not be right? I always wonder how much these views are based on moral sentiments. The reason a country should have austerity is because it deserves it. So what did it do to deserve this? It wasn't being profligate spenders. 

     "By allowing its banking system to spiral out of control, the tiny island has gotten itself into a situation where its only options are bad ones. If it wants to remain part of the euro zone—and evidently it does—it will have to downsize its bloated banks and bear some of the cost of the bailout, which, relative to the size of Cyprus’s economy, is one of the biggest in recent times. (At about sixteen billion euros, it’s close to sixty per cent of G.D.P.) That’s going to be tough on Cypriots, particularly wealthy ones who will see some of their bank deposits wiped out, but it’s hard to see any realistic alternative.

     Read more: http://www.newyorker.com/online/blogs/johncassidy/2013/03/why-germany-and-the-eu-are-right-to-bully-cyprus.html#ixzz2OkThhMcU

     The answer is it let its banking system "spiral out of control." Yet you can't help think of Krugman's point as well. How can leaving the EU make it's banking system collapse when the system in fact has already collapsed? 

      On the other hand isn't the final deal the kind that many liberals in teh U.S. wanted for the U.S banking system? Here the TBTF banks are being allowed to fail, the cost to the Cyprian people is going to be high indeed. 

       Beyond the question of Cyprus, we have two attendant issues. 

       1). Why is Cyprus being treated so much harsher than even Greece?

       2). Does this change the dynamic in the Euro now that the prospects of depositor liquidation is now on the table?

       A great exhibit A for Krugman's position is to check out Iceland. The implosion of their banking system in 2008 was very similar to what's happening to Cyprus' now. Yet, because they had their own printing press they avoided the apparent fate of Cyprus:  "an incredibly long and severe depression" that could see a 20% drop in GDP.